Foreign Threat in Treasuries Eases as U.S. Demand Jumps

Snow falls on a statue of Albert Gallatin, former U.S. Treasury secretary, outside the U.S. Treasury in Washington, D.C., U.S. Photographer: Andrew Harrer/Bloomberg

March 24 (Bloomberg) -- Overseas creditors such as China
and Japan enabled the U.S. to spend its way out of the recession
as they gobbled up 80 percent of the nation’s Treasuries. Now,
their holdings are dropping toward the lowest level in a decade,
while homegrown investors have picked up the slack.

Excluding Treasuries held by the Federal Reserve, U.S.
investors such as mutual funds and pensions have boosted their
stakes in the nation’s long-term interest-bearing debt
securities since the credit crisis to 33 percent, according to
the latest government data. With foreigners buying the fewest
Treasuries last year since 2006, domestic buyers have added $33
billion of bonds, according to JPMorgan Chase & Co.

“Domestic bidders are stepping in as foreign bidders are
stepping out,” William O’Donnell, the head U.S. government bond
strategist at RBS Securities Inc., one of the 22 primary dealers
that are obligated to bid at debt auctions held by the Treasury,
said in a telephone interview from Stamford, Connecticut.

Foreigners are slowing their purchases of U.S. government
debt as central banks and reserve managers tried to diversify
away from dollar-based assets on speculation the Fed’s policy of
printing money by buying bonds would debase the greenback. Among
fixed-income investors in the U.S., Treasuries are gaining more
favor as the extra yield provided by bonds of the most-creditworthy companies dwindles to the least since 2007.

Fed Purchases

With the Fed moving to end its own debt purchases this
year, the willingness of U.S. investors to finance a greater
share of America’s $12 trillion in marketable debt securities is
now providing a crucial source of demand.

Becoming less beholden to foreign creditors also means the
U.S. can limit the risk any reduction in their buying will
trigger a sudden surge in borrowing costs for the government,
companies and consumers.

Yields on 10-year Treasuries, a benchmark for everything
from mortgages to car loans and corporate bonds, have confounded
forecasters by falling this year as an economic slowdown in
China and political crises from Thailand to Ukraine helped fuel
demand for the safest assets among U.S. investors.

After reaching a 29-month high of 3.05 percent at the start
of the year, yields on the benchmark 10-year note ended at 2.74
percent last week. That compares with an average of 4.7 percent
in the past two decades and 5.84 percent for past 30 years. The
yield was 2.73 percent as of 12:32 p.m. in New York.

Foreign Holdings

Of the $8.1 trillion in U.S. government notes and bonds not
held by the Fed, overseas investors owned $5.4 trillion as of
January, data from the Treasury department and the central bank
compiled by Bloomberg show. The figures exclude Treasury bills,
which have maturities of one year or less.

The total is equal to about 67 percent, approaching the
lowest level since the government began releasing the data in
2000. Overseas investors scaled back their pace of U.S. debt
purchases last year, increasing their holdings by $228.2
billion, or 4.1 percent, the least in seven years.

China, the largest foreign creditor with $1.27 trillion of
Treasuries as of January, has slowed its accumulation to about
3.1 percent annually since 2010. That compares with an average
yearly increase of 34 percent in the 10 years before.

The reduction in buying comes amid concern the Fed’s
stimulus, which has flooded the U.S. economy with more than $3
trillion since 2008, will quicken the dollar’s weakness against
the yuan and deepen losses on its foreign-currency assets.

Dollar Weakness

The People’s Bank of China said in November the nation
doesn’t benefit any more from boosting those holdings.

“It’s no longer in China’s favor to accumulate foreign-exchange reserves,” Yi Gang, a deputy governor at the central
bank, said in a speech in November organized by China Economists
50 Forum at Tsinghua University.

China’s foreign-currency holdings stood at $3.8 trillion,
more than triple any other nation and bigger than the gross
domestic product of Germany, Europe’s largest economy. Since
China’s 2005 decision to let its currency float within a
restricted band set by its policy makers, the dollar has fallen
in eight of the past nine years against the yuan.

Japan, the second-largest foreign lender, has expressed
concern that repeated debates in U.S. Congress about whether to
raise the debt ceiling may risk a default and damage the value
of its $1.2 trillion of Treasuries.

During the last standoff in October, which caused a 16-day
U.S. government shutdown, Japanese Finance Minister Taro Aso
said its nation must consider the impact of a U.S. default on
its bond holdings, calling it a “big issue” for Japan.

Default Impact

In the past two years, Japan has added fewer Treasuries on
a percentage basis than at any time since 2007.

At the same time, U.S. debt investors are gravitating
toward longer-term Treasuries. The shift in favor of Treasuries
among U.S. bond buyers has occurred this year as yields on the
highest-rated company bonds have fallen to a level that doesn’t
justify the additional risk, said Thomas Graff, who manages $3.6
billion of fixed-income assets at Brown Advisory Inc.

The extra yield that investment-grade corporate notes in
the U.S. provides over Treasuries fell to 1.21 percentage points
last week, the lowest since July 2007, data compiled by Bank of
America Merrill Lynch show. That’s less than half the post-crisis peak of 2.72 percentage points in October 2011.

“We probably have a higher Treasury allocation in our
primary strategies than at any time since the crisis,” Graff
said in a telephone interview from Baltimore. Investment-grade
bond yields have “pushed the boundaries of reason. It’s hard to
find value other places.”

Higher Allocation

Bond mutual funds in the U.S. have already attracted at
least $33 billion this year, making individuals a likely source
of this year’s rally in Treasuries, an asset-allocation analysis
by New York-based JPMorgan released March 14 showed.

U.S. pension funds controlling $16 trillion are shifting
out of equities and into government bonds as last year’s advance
in American equities, the biggest since 1997, helped them slice
their funding shortfalls.

With pension-advisory firm Milliman Inc. estimating the 100
biggest U.S. corporate pensions are 95 percent funded on
average, the funds are buying long-term government bonds to
match liabilities and eliminate the risk of future deficits.

“There’s going to be continued appetite” for the longest-dated Treasuries, Steven Center, a fixed-income consultant at
Callan Associates, an adviser to pension funds with a combined
$2 trillion, said in a telephone interview from San Francisco.

U.S. government debt that matures in 10 years or more have
returned 6.1 percent this year, their best start since 2000,
index data compiled by Bank of America show.

Political Issue

The rise in domestic ownership may be helping dispel
concern that overseas creditors are gaining too much influence
over America’s finances, said Michael Materasso, co-chairman of
the fixed-income policy committee at Franklin Templeton
Investments, which oversees $320 billion of bonds.

After the financial crisis, the U.S. budget deficit
surpassed $1 trillion for four straight years as the government
boosted spending to bail out the nation’s banks and revive the
economy hobbled by its worst recession in seven decades.

The nation’s debt burden soared, and China surpassed Japan
to become the largest foreign creditor to the U.S. as their
combined holdings surged to $2.5 trillion.

Foreign ownership of U.S. debt became an issue in the last
presidential election as Republican candidate Mitt Romney said
in August 2012 that borrowing a trillion dollars from China to
finance more spending was unsound policy.

‘Constant Focus’

There used to be “this constant focus on the expansion of
the Treasury holdings held by China,” Materasso said by phone
from New York. “It doesn’t seem to be as much of a focus.”

Foreigners own more than twice as much as long-term
government debt as U.S. investors, meaning the largest creditors
such as China still have the ability to sway perceptions, said
Jason Rogan, managing director of U.S. government trading at
Guggenheim Securities LLC, a New York-based brokerage for
institutional investors.

“They still are a very important factor in the market,”
he said in a telephone interview. “You’d rather jump on board
with them than get run over by them.”

Fed Chair Janet Yellen also rattled bond investors after
saying on March 19 that the central bank’s benchmark interest
rate, which has been close to zero percent since 2008, may rise
about six months after it stops buying bonds. Yields on all
government securities surged last week, with those on the two-year note soaring by the most since June.

‘Real Problem’

The Fed has cut purchases of Treasuries and mortgage-backed
debt by $10 billion at each of its past three meeting this year
and economists in a Bloomberg survey forecast the bank will end
its monetary stimulus by year-end.

Since starting its third round of quantitative easing in
September 2012, the central bank has bought $655 billion of
Treasuries, data compiled by Bloomberg show.

Even though foreigners have slowed their purchases of U.S.
debt, there are few if any signs of an outright exodus.

On an absolute basis, Treasuries held by overseas investors
rose to a record $5.83 trillion in January as turmoil in
emerging markets fueled demand for haven assets.

“You need something in your portfolio that’s going to be
defensive because you never know where the next stress point
is,” Jack McIntyre, a money manager who oversees $45 billion at
Brandywine Global Investment Management LLC, said in a telephone
interview from Philadelphia.

Fiscal Balance

America’s improving fiscal balance means the government can
finance its spending without issuing as much debt.

Stronger economic growth and spending cuts have narrowed
the U.S. budget deficit to a seven-year low of $680.2 billion
last year, equal to 4.1 percent of the economy. That compares
with more than 10 percent in 2009. The Congressional Budget
Office forecasts the shortfall will drop about 3 percent this
fiscal year, close to average over the past four decades.

The U.S. current account, which measures the total imports
and exports of goods, services and financial transfers, narrowed
14 percent to a deficit of $379.3 billion in 2013, the least
since 1999, the Commerce Department said March 19.

“Things feel much better than they did five years ago,”
Shyam Rajan, an interest-rate strategist at primary dealer Bank
of America Corp., said by telephone from New York.